Moving on from Holtham: the fiscal deficit is more important than the funding gap

Publication of the final report of the Holtham Commission has opened, or re-opened, debate about how devolved government in Wales is financed.  The issue exciting a lot of politicians is the existence and size of a ‘funding gap’: the £300 million by which the commission found public services in Wales are ‘under-funded’ in comparison with England.  For Plaid Cymru, in particular, this finding has been a big political win – it’s taken as proving a long-standing Plaid argument, and it’s now a convenient area of agreement with Labour as well.  We can already see a ‘politics of underfunding’ emerging, with the funding gap being blamed for every area in which public services in Wales are seen as inadequate.

Blaming the funding gap for all Wales’s problems is rather beside the point, though.  The gap is, in fact, pretty small.  It’s about 2.1 per cent of the Assembly Government’s overall spending.  While it’s hard to argue that Wales is generously treated when it comes to the allocation of public resources, this doesn’t explain much of the problems in those services.  Would public services in Wales be dramatically different if the gap were filled overnight?  It’s highly unlikely.  Filling the gap would not be a panacea for Welsh health services, schools, universities or roads.  Doing so would remove a justifiable source of grievance, but problems in public services are much more to do with what government does and how it does it more than this particular gap.

And Plaid should be particularly cautious about how much emphasis they put on this funding gap.  They could quite easily win this battle but lose the war.  Given the scale of spending cuts that are looming in England, it would be quite easy to redress the relative imbalance in funding (which is what gives rise to the funding gap), while at the same time reducing the amount of Assembly Government’s block grant.   Remember that most departments in Whitehall are looking at 25 per cuts in their budgets, and even the effect of protecting spending on health and education in England is limited.  Those account for about 75 per cent of changes in the block grant; but cutting 25 per cent of the remaining 25 per cent would almost certainly eliminate it.  Wales could find itself receiving the now-talismanic 115 per cent of English spending on ‘comparable’ functions, without getting a single extra penny in public spending – indeed, conceivably by getting less. Arguments to increase the Assembly Government’s resources by talking about ‘fair funding’ would then have no weight at all.  The UK Government has shown no eagerness to do this to date, but it may well do in the next few years.

The Holtham Commission’s report is more interesting than just the work on the ‘funding gap’.  Among a feast of important points, two stand out.  One is the size of Wales’s ‘fiscal deficit’.  Holtham tells us that overall tax revenues in Wales are £17.1 billion (all these figures are for 2007-08).  I’ve calculated that this means Wales’s fiscal deficit – the amount by which all identifiable public spending in Wales (not just devolved spending) exceeds revenues – is £6.3 billion.  That’s a horrifying sum, and indicates the measure of how poorly Wales’s economy performs.  It gets worse if we look at that as a proportion of national income: it’s 14.2 per cent (using a GVA figure for 2007 from ONS data).

We get a better idea of what this means if we look at Scotland. the question of whether there is a Scottish ‘fiscal deficit’, and how large it is if there is one, is a complex and contentious one.  Thanks to a Scottish Government publication called Government Expenditure and Revenues Scotland (GERS for short), we have some quite good data about it. The most recent edition is available here, though for the rest of this post I’ve used data for 2007-8, as that’s what Holtham used.  There is a problem because of the question of how one treats North Sea oil tax revenues.  For Scotland, the GERS figures for 2007-08 give a fiscal deficit 9.8 per cent when North Sea revenues were wholly left out of the picture, 9.0 per cent of GDP when Scotland was allocated a per capita share of North Sea revenue, and 2.7 per cent of GDP when allocated an estimated geographical share of North Sea revenue.  And one mustn’t forget that Scottish public spending is both higher than the UK average (about 118 per cent of the average), and almost certainly significantly higher than could be justified on the basis of relative needs (which are probably around 105 per cent of average).  So Wales has a significantly larger fiscal deficit than Scotland, even without being treated on the same basis as England given its relative needs.  And that means Wales’s fiscal deficit would be worse if its funding were on a relative-needs basis – but Scotland’s would be much smaller (and might even disappear – I haven’t yet tried to calculate that). Improving Wales’s economic performance to increase tax revenue generated in Wales and so tackle that deficit is vital, the more so because all the efforts to do this up to now have produce little if any improvement.

The other important thing we learn from Holtham is about how Wales should be funded – whether a block grant is the right way to do that.  The Holtham Commission – a small group of expert professional economists – had little difficulty embracing for Wales one of the key points in the much more politically-oriented Scottish Calman Commission’s report: that devolution of public service functions, unaccompanied by financial responsibilities, means that there is a deficit of accountability, which can only be cured by ensuring that there is at least a measure of fiscal responsibility as well.  (Calman’s members were drawn from the unionist political parties and wider civil society, advised at arm’s length by a panel of economists and other experts.)  What’s intriguing – and has impressed Scottish commentators – is the careful way the Holtham Commission appraised the issues, and looked at the technical aspects of how a limited measure of fiscal responsibility would work.   When such a careful analysis supports the idea that this would work in practice for a poor part of the UK like Wales, as well as a relatively prosperous part like Scotland, it has to be taken very seriously.

Key to making this work are the changes the Holtham Commission propose to the block grant.  First, it needs putting it on a needs-related basis, and second the right mechanism needs to be used to calculate the reduction in the grant as a result of devolved tax powers.  Holtham devotes a whole chapter to discussing different ways of doing this and their effects, while Calman skates over it in a single sentence.   There are reasons to question this way of going about it – the amount of restoration work that the fabric of the inherited block grant needs to work reasonably well is huge, and will result in a system that is easier to put in place, but much more complex to operate.  There are strong arguments for a wholesale reconstruction of how a block grant works and is calculated, so that it’s more fit for purpose.  But the key point is that Holtham shows that this approach is workable, even for Wales, and even in times of public austerity.

None of this is to say that Wales should get less money from the public purse.  But it is to say two things.  First, it’s just unsustainable in the long term to expect public services to be paid for from revenues that others generate.  This is a clarion call for Wales seriously to up its game in its economic performance.  Even if a fiscal deficit can’t be eliminated, it can be reduced.  Second, it’s in everyone’s interest for Wales to do – for the UK Government as much as devolved politicians in Wales.  And the fact this is a pressing problem suggests that the tools Wales has are themselves simply not up to the task.  Broadly similar economic development policies (to attract large-scale inward investment) have been followed for many years.  There’s a limit to what they can attract in the modern world, where there’s plenty of cheap labour around the globe and plenty of governments willing to offer a range of incentives to attract it.  But the policy options open to the Assembly Government are limited by the powers it, and the National Assembly, have to use.  Fiscal policy may well have a part to play in developing a different approach to delivering policy, and also in the policy itself.

This ball is now in the UK Government’s court.  There are strong reasons for devolving some tax powers to Wales – for the accountability reasons Holtham discusses at some length, and to tackle the fiscal deficit and economic performance that it skates over.

And that’s where this creates a big question for the UK Government.  Its Programme for Government commits the coalition to ‘implementing  Calman’ for Scotland (as well as a bizarre commitment for a review for Wales, similar to Calman, if Wales votes yes in a referendum on Part 4, which is beside the point, and also dependent on stabilisation of the public finances).  But why not make that model at least available to Wales as well?  That’s what the Holtham Commission suggest, and it’s a compelling argument.  These problems can’t just be left to carry on as if they don’t exist.

This post also appears on Wales Home here, under the title ‘No more porkies – here is the real fiscal deficit’.



Filed under Calman Commission/Scotland bill, Devolution finance, Labour, Plaid Cymru, Wales

6 responses to “Moving on from Holtham: the fiscal deficit is more important than the funding gap

  1. Cegog

    UK £159.2BN deficit
    Wales £6.3BN deficit

    Wales’ population 5% of the UKs
    Wales share of the UK’s deficit 3.95%

    The point is this, Wales’ situation is dire, but the UK as a whole is a shed load worse. The UK is bankrupt. Lets get off this sinking ship.

    • I’m afraid you’re confusing several things here. First, you’re conflating the UK national debt – accrued over many years (part, I believe, goes back to the 1940s), with Wales’s annual fiscal deficit. That’s like confusing a balance sheet with a profit-and-loss account.

      Second, even on a current-account basis, a fiscal deficit isn’t the same thing as a national deficit. As devolution is funded by a block grant, the whole of the Welsh fiscal deficit is structural.

      In the case of the UK deficit, part is structural and part is cyclical. The cyclical part relates to factors caused by the economic downturn – higher spending on social security, bank bailouts and so forth, and lower tax revenues. That will be remedied as the economy recovers, and Keynesian economics suggests you can borrow quite freely for such purposes without any serious harm, and much short and medium-term benefit. That is, of course, rejected by more orthodox economists including those now in government.

      The structural part is the amount by which spending exceeds revenues in all conditions. Political fog obscures how much of the UK deficit is due to each (the Conservatives want to talk the amount up, Labour to talk it down. To quote George Osborne in the Emergency Budget statement, ‘The country has overspent; it has not been under-taxed.’ To redress that, you either increase tax revenues or reduce public spending. The UK Government has chosen to tackle it mostly by reducing spending, in the ratio of 80:20. That involves a set of essentially political decisions – about the extent to which the deficit is structural, and about how you redress it. But to suggest that Wales’s economic woes are caused by being part of the UK is, I think misconceived. They may result from policies pursued by the UK Government (that’s an arguable point), but independence wouldn’t be a panacea for them.

  2. Osian Lewis

    I think the argument for independence as made by Cegog, is one that I agree with but for reasons which are actually (for me at least) quite separate from these arguments here. Britain, or the UK Government I should say, has been clinging on to it’s ‘World Leader’ status and can’t seem to accept that the old days of ruling the world have long gone. This imperialistic attitude is draining Wales of its potential.

    Renewing a Nuclear deterrent system for around £70 billion for example, at the same time as threatening to take military action against Iran for their Nuclear ambitions. Going to war with two Countries, both without any decent reason (where are the WMDs in Iraq? Weren’t all the 9/11 bombers from Saudi Arabia? The Afghan public would rather be controlled by the taliban than the West etc).

    If Wales were not part of this imperialistic bully of a Government, we would not be forced to spend our money on activities to increase our influence in the world, and we would leave other Countries, languages and cultures alone, therefore making us less of a target for terrorists. We (Wales, Scotland, Northern Ireland and England) are only together to give us more of a voice internationally. It is of course true, that if we were to go our separate ways, none of us would have much of a say in the UN, but Wales would at least have a seat, as would the Scots and the English, separately. The UK needs to stop chasing the top step of the world leaders ladder. The British Empire is history, if only the United Kingdom itself was.

  3. Cegog

    The deficit I was on about is the annual deficit according to the ONS. I was not getting them confused to my point stands. You seem to be trying to baffle people with figures to make a political point….and the point that you are making is basically that you sopport the union. You said

    “…But to suggest that Wales’s economic woes are caused by being part of the UK is, I think misconceived. They may result from policies pursued by the UK Government (that’s an arguable point), but independence wouldn’t be a panacea for them”

    It is clear what your politics is, and therefore I’m not shocked at your conclusions about the Welsh/UK debt discussion

  4. Cegog

    just in case….here are the ONS figures showing UK DEBT and DEFICIT.

    In the calendar year 2009 the UK recorded a general government deficit of £159.2 billion, which was equivalent to 11.4 per cent of gross domestic product (GDP).

    At the end of December 2009 general government debt was £950.4 billion, equivalent to 68.1 per cent of GDP.

  5. Pingback: Doing the sums « Devolution Matters

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